India: FPIs brace for new tax rules, cost of investing goes up

Added on
03/04/2017

Mumbai: Global investors are bracing for a new set of tax rules that will increase the cost of investing in the country. With India's revised tax treaties with Mauritius, Singapore and Cyprus coming into force on April 1, capital gains on the sale of equity investments from those jurisdictions will be subject to taxation in India. Consultants advising foreign investors said funds will have to tweak their investment structures and strategies to align them with the new laws, reports Economic Times.

“With effect from April 1, foreign investors have to recognise that the cost of investing in India will go up on account of sunset of the capital gains tax exemptions under various treaties,“ said Siddharth Shah, partner, funds and corporate, Khaitan & Co, a law firm.

Overseas entities investing through countries like Mauritius and Singapore will now have to pay a tax rate of 7.5% on short-term gains from stocks. Domestic investors pay short-term capital gains tax of 15% for stock market trades. Short-term capital gains tax on stocks is applicable if profits are booked within a year of investment.

“While long-term investments for funds may remain unaffected, those where they book shortterm gains will now be taxable in India,“ said Shah. Derivatives traded in India remain exempt from the new capital gains tax under the revised India Mauritius tax treaty.

Though the tax rate of 7.5% is available till 2019 on such shortterm gains, it is lower than what domestic investors pay, availing of existing treaty benefits will not be easy with GAAR (general anti-avoidance rule) also coming into effect.

GAAR gives powers to tax officials to override tax treaty provi sions, making it difficult for investors to avail of benefits including the concessional tax rate during the intervening period. Experts said structures formed to take advantage of the tax treaty will be open to challenge on the grounds of lack of `commercial substance.' Over the past few months, funds have been busy re-examining their structures with a view to make them GAAR-ready or preparing themselves for a higher tax burden.

“Some foreign portfolio investors have been busy realigning their operations to ensure compliance with GAAR,“ said Rajesh H Gandhi, partner, Deloitte Haskins & Sells. “Since the Mauritius and Singapore treaty change has now resulted in a 7.5% tax on shortterm capital gains, there have also been instances where investors have been told that their NAVs (net asset value) would be impacted.“ About 60% of foreign investments in India comes via Mauritius and Singapore.

Tax consultants said some foreign investors may instead prefer to invest in India through participatory notes (P-notes) -a derivative instrument issued offshore to those who want to bet on the country's stocks and bonds without registering themselves with the Sebi.

“With P-notes being outside the GAAR purview, investors may find them to be more cost effective,“ Shah said.

Investments via P-notes had declined to a 43-month low of Rs 1.57 lakh crore in December but rebounded in January to `1.75 lakh crore before dropping again to Rs 1.70 lakh crore in February.

Various versions of P-notes are being offered by brokers to overseas clients.

“Some of the prime brokers have started offering different terms and products in P-notes and it would be interesting to see how investors view these in comparison to directly investing into India as foreign portfolio investors,“ said a tax consultant.“They have made a business out of GAAR and P-notes.“

But not all foreign investors will be willing to pour money into India through P-notes as GAAR could still be applied.

“The issuers of P-notes themselves will need to factor in the GAAR risk,“ said Shah.

Some FPIs have adopted a wait and watch strategy, said Amit Singhania, partner, Shardul Amarchand Mangaldas.

“While the recent GAAR circular is benevolent as it clarifies the issue of grandfathering in respect of compulsorily convertible instruments, there is still some ambiguity around certain type of investments (like optionally convertible instruments),“ said Singhania. “ Also there is a hope that some clarification or leeway may just be carved out under GAAR for FPIs.“

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